Statistics Matter: Oil, Dollars, Euros & Gold

Only problem is… despite being a print subscriber, the WSJ still prevents me from accessing their content online. Bleh. Thank goodness for Rupert Murdoch, right? 🙂 In any case, I am still scanner-equipped, so I can share the better points with you.

Check out this graph. Let it sink in.

Maybe I’m making too big a deal about this, but I found this chart incredibly fascinating. What this basically says is that if the dollar had stayed even with the Euro since 2000, then we’d have $57 Oil, not $100 Oil. So an increase, yes, but not nearly as shocking. More importantly, if the dollar was “as good as gold”, then literally the price of oil would have just barely risen at all, maybe to $30.

It makes you realize how much the topics of the day (peak oil, dependency on foreign supplies, etc) are controlled by economic perspective. I’m not saying anything about the quality of those issues, or the validity of those topics. I’m just pointing out the obvious – the sensationalist nature of seeing a high dollar value on oil is likely fueling the interest in those topics.

However, as I read this piece, it made me wonder, really, what does $100 dollar oil really mean? Does it mean that oil is dearer, or that the dollar is cheaper? Or both?

The reason I titled this post with the preface, “Statistics Matter”, is because I realized today that of all the disciplines and fields I have had the occasion to study and practice over the past 15 years, the fundamental concepts that underly the mathematics of statistics seem to always be valuable, if not essential. (In fact, Against the Gods is one of the books I recommend to people regularly). In fact, I’m probably going to blog on a couple other topics this weekend that all highlight the importance of understanding statistics.

The insight here, which is so common it’s almost trite, is the insight on correlation vs. causality. Correlation measures how often when one thing happens, a second thing also happens. The relationship between their occurrence. Causality is literally the measure of whether when one thing happens, it causes the second to happen. The confusion that normally happens is that people assume that correlation implies causality, when in many cases, it doesn’t.

In my Introduction to Statistics class, 15 years ago, they gave this example. Many people with yellow teeth also develop lung cancer. They are highly correlated. But getting your teeth whitened will not prevent lung cancer. Why? Well because there is a third thing, smoking, which actually causes both yellow teeth and lung cancer. Yellow teeth are positively correlated with lung cancer, but they don’t cause it. Seems obvious, but check out in your daily news how often you’ll see reports of studies that demonstrate nothing but correlation. Health fads are almost all started this way.

Back to Oil.

This article made me wonder – is the weak dollar the reason for $100 oil, as this article suggests, or is $100 dollar oil the cause of the weak dollar. Alternatively, is there a third cause, not mentioned, which actually is weakening the dollar and making oil more valuable?

The great thing about economics, of course, is that almost everything is inter-related. As a result, I’ve always found it very difficult to use macro-economic theory to identify causal factors, except in retrospect. (Hence the joke about economists predicting 19 of the last 7 recessions…)

I accept that one explanation, based on the data in the article, could be that oil hasn’t really become more expensive, in absolute terms. It’s the dollar that has weakened, and that makes it seem like oil is expensive to Americans.

Alternatively, it also seems plausible that since oil is a external good that is predominantly sourced from outside the US, and since there has been a historical shift from our oil-producing partners from being dollar-denominated to a more balanced basket-of-currencies, that the increasing demand for oil has shifted the marginal demand for currencies away from the dollar, and towards previously underweighted measures of value like the Euro and gold.

My bet here is that neither of the above really explains the whole situation. It seems likely that there are a large number of factors affecting the value of the dollar and the value of oil, and the end result has generated a falling dollar and rising value for commodities, including gold & oil.

This issue of causality really matters, however, because if it is in fact a weak dollar which is the causal factor, we have very limited policy options. Let me leave you with the summary thoughts from the article:

This piece of the puzzle really worries me quite a bit – if indeed the rising prices we see are a monetary phenomenon, then we are really stuck between a rock and a hard place with the mortgage/credit issues and the weak dollar. What we could actually be seeing is a magnification effect that has spanned across multiple business cycles, each time the liquidity “solutions” getting larger and larger. This time, the liquidity needed may be so large that it’s actually finally breaking the dollar. Not surprising, really, since it’s pretty easy to argue that the size of the US home mortgage market is actually big enough to really matter versus the aggregate net value and annual product of the United States.

It could be that the future has already been written in this regard – the price we’ll pay over the next 5-10 years from the housing bubble will be measured in a weaker dollar. And that will inflate everything, including our most dear commodities, like oil. We may have to face the fact that liquidity may solve market failures that surround frozen credit markets, but there will be a price to pay.

great post adam – very thoughtful. anything that comes out of wsj editorial room should be taken with a grain of salt though. somehow they found a way to put in the same sentence the current pathetic and deteriorating state of the us economy (i.e. massive current and fiscal deficits) and democratic president of 30 years ago. the right continues to pray at the altar of supply side religion, despite overwhelming scientific STATISTICAL (see piece by James Surowiecki in New Yorker 12/07 for a very quick but smart summary) evidence that it does not work – oh oh, i am starting to rant. If you have not already, I would recommend you read Bernstein’s other book – The Power of Gold – it’s great.

I’ve read the Power of Gold – definitely great, although not as great for me as Against the Gods.

I think it’s always fair game to remind people of the 1970s, truly our modern equivalent of the economic dark ages. Nixon (price controls), Carter (everything), all history that we don’t want to repeat.

the solution to very high oil prices is
1. slow down significantly the growth of the US money supply, which weakens the dollar. This suggests that the federal govt. MUST reduce spending.
2. raise interest rates – slowly , but consistently – to encourage investment in the USA, which will increase the demand for dollars and thus raise its value.
3. develop, aggressively all forms of energy in the USA; solar, wind, nuclear, coal, coal gasification, oil, gas, hydrogen, etc. Any producer of “energy, ” by federal legislation, should be exempted from any and all income and sales taxes for a period of 30 years to encourage new investment in all forms of energy production and distribution.
4. Require that the federal govt. establish ONE standard for gasoline to maximize the very restricted refinery capacity in the USA.
5. Streamline environmental regulations such that refineries and nuclear plants can be constructed in a timely manner.
6. Follow the French model for storage and recycling of nuclear waste.
7. Enact federal legislation exempting from ALL taxes all revenues generated through the sale of any and all hydrogen powered vehicles; golf carts to trucks, cars,, airplanes, whatever; for at least 30 years.

It is the gross incompetence,stupidity and corruption of our congress and presidents – whose primary activity is generating funds for re-election, that has caused the energy “problems.” These politicians pander to any and all groups that will fill their re-election coffers, including the left wing, hate America first radical environmentalists.
Despite the success of 35 years of oil drilling at the North Slope of Alaska, drilling in the Gulf and the very stormy N. Atlantic off England and Norway, the success of nuclear power by France and the US Navy, and now the construction of several new nuclear plants in Scandanavia, these radical eco-Nazi’s insist that finding oil and gas is an ecological disaster.
What crap.

I like this article alot. I think that Americans are really felling the price of oile because the CPI (Consumer Price Index) has been altered by beaurocrats to the point where Housing, food, and energy prices no longer impact the CPI value as it did pre-Nixon. When the CPI under-reports the inflationary results of Federal resrve Policy, it makes lower interest rates more attractive to the Fed. That in turn increases the money supply but the labor rates, Social Security benefits and other income sources are not properly adjusted for inflation and the costs of these goods (Housing, energy, and food) are really hard-hitting.

Obviously there are other factors. What I am saying though, is that labor rates are not in step with inflation because no-one bothers to really measure it anymore. This article fully illustrates the danger in trying to manage markets. Free Enterprise markets, less governmment control is required.

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